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Dividend growth investing, growth at reasonable price, long-term horizon
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I have been working on a portfolio that I believe can provide me with steady capital appreciation 45 years or so (into my retirement) into the future: my dividend growth portfolio.

This portfolio had been a work-in-progress for nearly a month now, and I finally have decided on the final 25 stocks that are going to make up my portfolio. Although the list has been decided, I may remove any stock from my portfolio if something listed here happens:

  1. Decrease/Elimination Of Dividend
  2. Uncertainty With Future Dividend Payments
  3. Losing Market Share Rapidly/Not Competitive Enough/Fundamental Problems

My Strategy

Here is my strategy, originally published in this article:

This strategy may not be suitable for everyone as it covers a time frame of 45 years. Using this savings calculator, if I invest an initial amount of $30,000 into some dividend stocks, and add $400 monthly over 45 years, and grow the money by 7.3% yearly. (The Dow Jones Industrial Average (DJIA) had appreciated by 6.2% yearly from 1960-2010. Assuming that it appreciates the same way over the next 45 years, and that dividends of the portfolio will be sustained at around 3%, returns averaging 7.3% should be easily achievable. Furthermore, as seen here, most dividend aristocrats are able to beat both the market and inflation hands down.), I will get $2,466,399 (product here) in today's dollars, which would equate to around $370,000 worth of buying power 45 years later (calculated using dollartimes.com, assuming that rate of inflation over the next 45 years will be equivalent or close to the rate of inflation over the past 45 years), and should be enough for a good, modest retirement, along with other savings along the way.

But of course, the numbers above differ for everyone depending on their age, financial condition, their investment horizon and some other attributes. You can create your own (similar) dividend strategy through the calculator I tagged above.

I want to make a few changes to the above calculations. After backtesting my portfolio (as you will see later in this article), I had obtained a 10.7% return over the past 10 years. Assuming that no other variables are changed, and I increase the estimated return (previously 7.3%) to 8.3%, which should be achievable in my opinion (I know past performance is not a representation of future performance, but I think 8.3% is a fair estimate), I would receive a final portfolio value of $3,574,248, which equates to $520,000 in today's buying power.

Portfolio Management

This segment remains the same as the previous article's.

To manage my portfolio, I plan to check the news for the stocks in my portfolio every weekend (any day), and read articles on great sites like Seeking Alpha, Yahoo Finance, MSN Money or The Motley Fool. Besides this, when stocks are more overvalued (most stocks are still fairly priced at the moment), I plan to get loaded up on cash (I will add $400 monthly) and just collect my dividends. I will then wait for stocks to be more undervalued (e.g., recession, correction) before buying more stock, and will only sell when the dividend stocks decrease their dividend or announce news unfavorable to investors.

When I Will Buy

As some of you know, I have only some of the stocks mentioned in this article. I plan to buy all eventually, and I will try to buy these stocks as close to fair value as possible. The two most overvalued stocks (by comparing prices to their nominal P/Es) are Colgate-Palmolive and Automatic Data Processing, therefore, these stocks may be bought only much later. My limit buy price is 4% above the 2013 (year-end) estimated price. Although some stocks are not good buys at the moment in my opinion, the quality of their businesses and brands are not compromised.

The Mission Of The Portfolio

The mission of this portfolio is to provide myself with steady capital appreciation and a growing stream of dividends to be reinvested into the respective companies. Besides this, I also aim for a portfolio that will yield around 4%, and this dividend, along with the returns in the stock price itself, be able to beat both inflation and the major indexes over the years. Later in life during retirement, I also aim to live solely off these dividends, although I would sell some stock if needed, and have a good, modest retirement (along with my family).

But before I present the 25 stocks in my portfolio and their qualities, I just want to say thank you to all who readily helped me when I had any problems with understanding any concepts, or gave me constructive criticism when my understanding of certain topics was incorrect.

The Stocks

Here are the stocks making up my portfolio:

CompanyConsecutive Dividend Increases (Years)Dividend Yield (%)5-Yr Dividend Growth
Automatic Data Processing (NASDAQ:ADP)383.014.2
Aflac (NYSE:AFL)+302.617.5
Alliance Resource Pt (NASDAQ:ARLP)+108.013.6
Colgate-Palmolive (NYSE:CL)492.412.7
Chevron (NYSE:CVX)+253.39.0
General Mills (NYSE:GIS)93.211.1
Genuine Parts (NYSE:GPC)563.26.3
Intel (NASDAQ:INTC)+94.414.4
Johnson & Johnson (NYSE:JNJ)+503.59.1
Kimberly Clark (NYSE:KMB)403.57.8
Kinder Morgan Energy Pt. (NYSE:KMP)+166.47.2
Coca-Cola (NYSE:KO)502.78.7
Kraft Foods Grp. (NASDAQ:KRFT)0 (Spinoff from Kraft Foods, previously KFT)4.3Spinoff
Lockheed Martin (NYSE:LMT)105.121.1
Lorillard (NYSE:LO)55.227.5
McDonald's (NYSE:MCD)363.520.4
Altria (NYSE:MO)445.315.0
Omega Healthcare (NYSE:OHI) +107.710.1
PepsiCo. (NYSE:PEP)403.112.2
Procter & Gamble (NYSE:PG)563.211.2
Southern Co.(NYSE:SO)114.54.1
AT & T (NYSE:T)295.25.3
Waste Management (NYSE:WM)94.29.1
Wal-Mart (NYSE:WMT)+382.316.5
Exxon Mobil (NYSE:XOM)+302.67.6

Stocks that are trading at or below fair value have an plus (+) next to them.

Qualities Of The Stocks

Firstly, I am proud to say that the 25 stocks presented in the table above are included among the Dividend Champions, Challengers and Contenders, or the CCCs, as maintained by David Fish monthly (except for Kraft Foods Group, a spinoff from the former Kraft Foods). The list can be obtained here. This essentially means that all of the stocks listed in this list have had at least five years of consecutive dividend increases.

In addition, all of the stocks, except Aflac (which had dropped 80%), had dropped less than what the S&P 500 dropped during the 2008 recession. Aflac was not taken off, as it had maintained its dividends through the recession while other financial dividend aristocrats, including State Street (NYSE:STT) or Bank of America (NYSE:BAC), were cutting their dividends by a big deal (BAC cut its dividend from $0.64 to $0.01 during the recession). For more information, click on this link to one of my articles about Aflac.

Besides this, I feel that all the stocks in my portfolio are needed by consumers or corporations, and have a purpose for existing. For example, I have Wal-Mart, which is the largest big-box discount retailer with 2011 revenues of $464B; Coca-Cola and PepsiCo, which are the two leaders in the soft drink industry by market share; AT&T, which is the leading telecom company in USA by 2011 revenues and market cap; Exxon Mobil and Chevron -- the two oil majors; Kinder Morgan, which offers its pipes as a "toll road" for oil; Colgate-Palmolive, Kimberly Clark and Procter & Gamble as some the biggest providers of personal products around the globe by comparing the companies' market caps; and McDonald's, Kraft Foods Group and General Mills, which are the biggest providers of food around the world by revenue in 2011. People (and/or corporations) need these companies and services.

Additionally, all the stocks in this list have 5-year dividend growth numbers outpacing inflation, with the slowest grower of all, Southern Company, growing its dividend at 4.1% over the past five years, which is still acceptable in my view. I would start to be cautious when a company's dividend growth rate dips below 4%, which is my limit.

The Dividends

My portfolio has a current yield of 4.21%, which slightly exceeds my target of having a portfolio yielding 4% annually. This, along with my portfolio's 5-Year dividend growth of 12.2%, should outpace inflation and beat the markets hands down, which is what I am aiming for.

Valuation

Speaking of valuation, my portfolio is fairly valued at the moment, with its average P/E ratio at 15. Additionally, none of the stocks in my portfolio are severely overvalued. The most overvalued stocks in my portfolio -- ADP and Colgate-Palmolive -- are only moderately overvalued, after comparing their current valuations to their average P/Es. My portfolio's flow of dividends is also sustainable, with the portfolio's average payout ratio in the 60% range.

Other Clarifications

I also want to clarify that although I avoided stocks that have payout ratios of more than 80% in the past, I have some of them in this portfolio, like Kinder Morgan and Omega Healthcare. But as I have said in the introduction to this article, I have learned a lot speaking to both authors and commenters, and I have learned that these stocks are capital intensive stocks (REITs, MLPs), and their payout ratios should be calculated by dividing dividends by their funds from operations (FFO) and not their income. FFO is calculated by adding depreciation and amortization to the company's net income number, and is mainly used by capital intensive stocks. In addition, their valuations should not be calculated by price/earnings -- instead, the formula for these stocks should be P/FFO.

10-Year Backtesting

Besides doing a whole lot of research on the company and its dividends, I also backtested the above portfolio against the Dow Jones Industrial (DJIA) and the S&P500 indexes. I found it appropriate to backtest against two indexes as the I have eight Dow components and many other blue-chips in my portfolio. On the other hand, I backtested against the S&P500, as it is one of the most broadly based indexes. During this period, my portfolio outperformed both the indexes in nine out of the past 10 years, which is a result that I am quite satisfied with, with 2009 as the only year my portfolio underperformed. From this, I realize that my portfolio is considerably defensive, as it has outperformed in all the years except those after a big bear market, like in 2009 (the year my portfolio underperformed). In addition, during the big down years of the past decade, 2002 and 2008, my portfolio had outperformed both the S&P 500 and the Dow by considerably larger margins than other years. The backtesting results are shown in the table below.

YearMy Portfolio's Returns (%)S&P 500 Returns (%)Outperformed By (%)
2002(-11.6)(-23.4)11.8
200329.026.42.6
200417.39.08.3
20057.33.04.3
200619.413.65.8
200715.83.512.3
2008(-12.2)(-38.5)26.3
200917.923.5(-5.7)
201016.012.83.2
201115.90.015.9

YearMy Portfolio's Returns (%)DJIA Returns (%)Outperformed By (%)
2002(-11.6)(-16.8)5.2
200329.025.33.7
200417.33.29.0
20057.3(0.6)7.9
200619.416.33.1
200715.86.49.4
2008(-12.2)(-33.8)21.6
200917.918.8(-0.9)
201016.011.05.0
201115.95.510.4

$30,000 invested into my portfolio in 2002 would have grown to $82,855.93 by the end of 2011 (which equates to around 10.7% in annual growth). The S&P 500 with the same $30,000 invested would only have grown to $38,191.05 and the Dow, with the same $30,000, would only have grown to $36,562.25. This backtest proves all the more that by buying high-quality dividend stocks, an investor can outperform the markets quite considerably.

Backtesting Considerations:

1. Kraft Foods Grp, the spinoff from what was once Kraft Foods, was not included in the backtest.

2. Lorillard, which had its IPO in 2008, was only included in the backtest in the years 2009-2011.

Finally, although I have a confirmed portfolio of stocks, I would like to hear what you think about the stocks in my portfolio and how I can improve it. Your opinions and comments will be greatly appreciated.

All information were sourced form Finviz, dripinvesting.org, Yahoo Finance and investment-calculator.net. All prices and figures are based on the December 17, 2012 closing price.

Source: Investing In Dividend Growth Stocks: My Portfolio Of 25

Additional disclosure: I may initiate positions in any of the stocks listed in this article when I feel that they are priced fairly/attractively, therefore, I will initiate positions in the near future, but not necessarily within the next 72 hours.